Interim Review of West Coast Main Line Franchising Errors Published by Government

Published 5th November 2012

London - Laidlaw Report suggests Departmental for Transport in a state of chaos

The Secretary of State for Transport (SoST) has addressed the House of Commons following the publication of initial report by the Laidlaw Inquiry into the West Coast Main Line, and the general rail franchise debacle.

The Rt. Hon. Patrick McLoughlin (SoST) was at pains to make clear that train operations will carry on as normal from the end of the Virgin franchise on the West Coast Main Line (WCML) line after December 9th. The franchising competition was cancelled on October 3rd when Mr McLoughlin announced the cancellation of the competition to run the Inter-City West Coast franchise because of the discovery of unacceptable flaws in the procurement process run by the Department for Transport (DfT).

Standing by his decision

He reiterated that this was a very regrettable decision to make prompted by mistakes that should never have happened. He launched two independent inquiries, and the one led by Centrica chief executive Sam Laidlaw has now reported its interim findings.

This interim report explains what went wrong, and from that basis he will now carry out further investigations into why this happened. Mr McLoughlin said “To be blunt, these initial findings make uncomfortable reading but they provide a necessary and welcome further step in sorting this out”.

The Government will need to see the full and finished report before it can comment in detail on any conclusions but it is clear that the Inquiry has identified a number of issues which confirm that my decision to cancel the franchise competition was necessary.

What went wrong – initial report findings

The report summarises its findings in a hard hitting section which said that there was a lack of transparency in the process for determining the level of ‘The Subordinated Loan Facility (SLF) required - and that the DfT knew this. The DfT made this worse by not complying with its own guidance concerning the required SLF calculations.

It must be stressed that the Laidlaw Report contains only interim conclusions with the final report die out at the end of November. Law and accountancy firms Linklaters and Ernst & Young have been involved giving an external perspective to what went wrong.

The short amount of time available for the interim report meant that much documentation had not yet been obtained from the DfT or obviously scrutinised by the Inquiry team. The team were also mindful that staff had been suspended so this parallel investigation could not be compromised.

The Subordinated Loan Facility explained

The main thrust of the Inquiry was to examine what is called ‘The Subordinated Loan Facility’ (SLF), or in plain English, how much money would be put up as a Bond (collateral) by the franchisee in case they went bust. The calculations for this are based on the risk that predicted income would not match actuality over the length of the franchise and the chances of a Franchisee going bust.

These calculations are based on how the economy performs and involved in this case, forecasting up to 15 years in advance for inflation and Gross Domestic Product for example. If the winning franchisee gets these calculations wrong, it goes bust as with the two East Coast Main Line franchisees GNER and National Express.

This leaves the Government with a potential financial hole to cover unless the SLF has been correctly calculated. Virgin’s claim was that the £200m requested by the DfT for the First Group bid should have been £600m. The calculations were confused by the DfT in using today’s values against forecast values and not equalising them consistently.

The report’s main findings were:

Bidders in the WCML Franchise process were not provided with adequate information reliably to predict the likely size of any SLF requirement to be imposed by the DfT. This made it difficult for bidders properly to determine the optimal capital structure for their bids.

The amount of the SLF ultimately required by the DfT in respect of the two leading bids was not determined in compliance with the DfT’s own SLF guidance.

The DfT’s ultimate determination of the level of SLF required in respect of the bids of First and Virgin was influenced by extraneous factors with the result that the bidders were treated inconsistently.

Departmental Chaos?

The SLF amount required for the Virgin and First Group bid was calculated in different ways and therefore inconsistent with each other due to a lack of planning and preparation. The organisational structure of the DfT and lack of clarity as to who was supposed to carry out what role is also stated as contributing to the errors as was a lack of staff following cutbacks. This in turn led to a poor quality assurance process, described as ‘inadequate’.

So it seems that published guidance by the DfT was not complied with by themselves when bids were being processed. There were also inconsistencies in the treatment of bidders and of technical flaws were confirmed in the model used to calculate the amount of risk capital bidders were asked to provide to guard against the risk of default. Had this been done correctly, the SLF levels would have been significantly increased.

Early challenge ignored

Franchise bidders told the DfT in March 2012 that they thought the SLF procedures were being incorrectly applied and that there was a lack of transparency. The DfT knew this and that they could face a legal challenge on this but they took the view it was a risk worth taking.

What happens next?

Mr McLoughlin said that we will ensure that passengers continue to be served by the same trains, with the same frontline staff, the same services, using the same tickets and interestingly, enhanced future timetables. The Department is making good progress in its discussions with Virgin on how they will operate the line for a short period of up to 14 months while a competition is run for an interim agreement. We are discussing their proposals for improved services over this period and an enhanced compensation scheme for delayed passengers.

In dealing with this, my Department has been frank and open about its mistakes and is absolutely determined to find out exactly what happened.

They said:

The Secretary of State also said that we will keep delivering for passengers and continue with the unprecedented levels of investment in trains, stations and railway lines and repeated his decision to limit train fare rises to an average of inflation plus one per cent, instead of RPI+3, for the next three years which he claimed demonstrated this government’s total commitment to Britain’s railways.

Sam Laidlaw, the author of the interim review is also a Department for Transport non-executive director said:

“In the limited time available this is necessarily only a preliminary report. What is clear however is that in seeking to run a complex and novel franchising competition process, an accumulation of significant errors, described in the report, resulted in a flawed process.

“These errors appear to have been caused by factors including inadequate planning and preparation, a complex organisational structure and a weak governance and quality assurance framework. The full causes and the lessons to be learnt will be addressed in the final report of my independent Inquiry to be published at the end of November.

“Firm judgments should not be made based upon what are provisional findings or wider conclusions drawn at this stage.”

Second inquiry underway

There is a second Inquiry being led by Richard Brown, Chairman of Eurostar looking at if the franchise model is as good as it could be and this will report in due course.

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